“Reasonable compensation” has become a real hot button for the IRS when it comes to small businesses that file Subchapter S tax returns. As a business owner, it is your responsibility to accurately determine and document your Reasonable Compensation for the services you provide to your business. Reasonable Compensation is the salary or wages that you, a shareholder-employee of an S Corp, pay yourself for the work you perform for your company.

The IRS requires that all shareholders of S Corps who perform services for their company pay themselves Reasonable Compensation, and it must be paid prior to taking any distributions. There are two ways to think about Reasonable Compensation:

  1. Replacement Cost: What would it cost your company to pay someone else to provide all the services you currently provide?
  2. Fair Market Value: What would other businesses in your community pay you for the services you currently provide to your company?

The key to establishing reasonable compensation is determining what you do for your S Corp. In addition to direct generation of revenue, you should also compensate yourself for your administrative work. It is very important that your Reasonable Compensation figure is well researched and well documented.

Numbers That Work is here to assist you with this issue.  We have specialized training and great tools that can help you accurately determine and document your Reasonable Compensation figure. Please contact us if you would like to discuss this issue further or to have us prepare a Reasonable Compensation Report for you.

A Reasonable Compensation Report is a detailed report that establishes your Reasonable Compensation using criteria outlined by the IRS.  To generate a Reasonable Compensation report, you will complete a short on-line (or on paper) interview (about 15-20 minutes). When complete, you and I can go over the report and make any needed changes before locking in your Reasonable Compensation figure for the year.

The best time to establish your Reasonable Compensation figure is now, before an IRS examination. Reasonable Compensation has become an big IRS hot button and we have been told to expect an increase in examinations of S Corps (examinations were up 33 percent for 2011 to 2012). Completing a Reasonable Compensation Report is easy and provides a defensible position to an IRS challenge.